Meaning
Detailed regulatory requirements for the documentation of related party transactions and outbound payments appear in the guidance issued by the State Administration of Taxation during 2016. This bulletin 2016 no 42 governs the annual reporting of intercompany dealings and the preparation of transfer pricing documentation files for taxpayers in China. It defines the thresholds for different levels of reporting and establishes the mandatory contents of the master file, local file and special issue file.
The application of these rules stops when a taxpayer falls below all the specified financial thresholds for transaction volume and related party debt. It provides the framework for the anti-avoidance measures used by the tax authorities to monitor the profit shifting activities of multinational groups.
Reporting Requirement
Every company that engages in transactions with related parties must submit an annual reporting form along with its enterprise income tax return. Under bulletin 2016 no 42, the report includes details on the nature of the transactions, the location of the affiliates and the pricing methods used. Companies must also disclose whether they have received any tax incentives or have participated in any cost sharing agreements.
This reporting serves as the primary risk assessment tool for the tax bureau. When the reported data shows inconsistencies with industry norms, the bureau may request the company to provide its full transfer pricing documentation. The requirement for a master file applies to groups that have a cross-border related party transaction and meet the consolidated revenue threshold.
This file provides an overview of the global business operations and the allocation of income and taxes among different jurisdictions.
Documentation Hierarchy
The structure of the compliance files is divided into three distinct categories based on the complexity and volume of the business activities. For the local file, bulletin 2016 no 42 requires a deep analysis of the local entity’s functions, risks and assets used in the business. This document must include a benchmarking study that compares the profit margins of the company against independent peers.
The special issue file is reserved for specific high-risk areas such as cost sharing arrangements or thin capitalization issues. If a company exceeds the threshold for related party debt-to-equity ratios, it must justify the interest payments in this special file. The preparation of these documents must be completed by the deadline following the tax year, and they must be provided to the tax bureau within twenty days of a request.
Failure to meet these deadlines can result in the loss of the right to use certain tax benefits and the imposition of a higher interest rate on any tax adjustments.
Compliance Boundary
The obligations set out in this regulation do not apply to transactions between two domestic companies that are not subject to different tax rates. Although bulletin 2016 no 42 is comprehensive, it excludes small-scale enterprises that do not reach the annual transaction limit of two hundred million yuan for tangible goods. Service transactions have a lower threshold of forty million yuan, reflecting the higher scrutiny on intangible transfers.
The rules also do not apply to entities that have already signed an advance pricing arrangement with the tax authorities for the covered transactions. Once an arrangement is in place, the reporting requirements of that agreement take precedence over the general rules in the bulletin. This boundary ensures that the tax bureau focuses its resources on the largest and most complex multinational operations where the risk of tax leakage is highest.
Accuracy in these filings is the only way to avoid the heavy penalties associated with non-compliance.
